Previous Year Question
Consider the following statements and state which is/are correct?
The sub-prime crisis which hit the U.S. economy was caused by sudden increase in oil prices.
The crisis led to default in home loan repayment.
It led to failure of some U.S. banks.
Sub-prime crisis caused crash in Indian Stock Market.
Choose your answer from given code :
1 only
2 and 4 only
2, 3 and 4 only
1, 2, 3 and 4
Correct Answer: C
Detailed Solution
Statement 1 is incorrect. The primary cause of the Subprime Mortgage Crisis in the US economy was not an increase in oil prices, but large-scale housing loans to high-risk borrowers, weak lending standards, and declining residential property prices. A Subprime Mortgage is a housing loan provided to borrowers whose repayment capacity or Credit History is relatively weak. After the US housing market began declining around 2006, the crisis became severe during 2007–08.
Statement 2 is correct. Declining residential property prices and weakening repayment capacity among many borrowers led to increased defaults on mortgage instalments. Many loans had been sold in financial markets as Mortgage-Backed Securities (MBS). Rising mortgage defaults reduced the value of these securities and caused substantial losses to financial institutions.
Statement 3 is correct. The Subprime Crisis caused severe financial losses to several US financial institutions, and some banks failed. The major US Investment Bank Lehman Brothers filed for bankruptcy protection on 15 September 2008. During the same period, Bear Stearns was acquired by JPMorgan Chase with government assistance, while Fannie Mae and Freddie Mac were placed under government conservatorship. These developments further intensified the Global Financial Crisis.
Statement 4 is correct. The US financial crisis also affected the Indian stock market. Global uncertainty, capital withdrawals by Foreign Institutional Investors (FIIs), and increased risk aversion among investors caused a sharp decline in Indian equity markets. The BSE Sensex declined from its peak of 20,873 points on 8 January 2008 to 8,160 points on 9 March 2009, representing a fall of approximately 60.9%. Indian banks had limited direct exposure to Subprime Assets, but India's capital market was affected because of its integration with global financial markets.